Growth-oriented advisory firms face challenges in today’s environment of rapid consolidation. Those who seek to purchase another practice are encountering high prices and terms geared to the sellers. What is the best growth strategy for your firm? Should you try to buy another practice in a hot market, or should you focus on recruiting and developing organically? Either way, the goal is to build your brand, create capacity, achieve critical mass and construct an enduring business.
A recent conversation with a $2-billion wealth management firm brought this challenge into sharper focus. They have multiple office locations, but only one has reached critical mass. Most are staffed by a single advisor and an assistant. These satellite office practitioners function as rainmakers, lead advisors and quality control officers for their own location.
Advisory firm leaders recognized their high dependency on practitioners who lack deep ties to the organization. These advisors acquire clients through individual relationships, not because of firm brand. They think and act locally, which means that clients are not benefitting from the depth of talent the larger firm has to offer. It would be difficult to argue that clients belong to the firm rather than the practitioner should they part ways.
Leaders of the firm responded to this challenge with a plan to buy practices in their existing markets and contiguous locations, in an attempt to get to critical mass more quickly. As a result, they made several runs at large advisory businesses, but were priced out of every bid.
Every target acquisition had multiple offers, which made each deal more of an auction than a negotiated purchase. They decided to go down market to smaller practices with the hope of making more affordable purchases. Even when bottom fishing, however, they encountered owners with inflated perceptions of value.
At what point do these prices make sense? Solo practitioners seeking purchase offers typically have just a few years left in their careers. They are looking for meaningful sums to help fund their own retirements — yet their client bases are the same age or older and are already deep into the de-accumulation phase. Within these aging solo practices, client and asset attrition usually outpaces new business development, which occurs accidentally rather than systematically. Not much exists to justify a high price.
Compounding price inflation is an expectation of a larger down payment. In the past, buyers commonly paid 20-30% of the agreed-upon valuation up front, with the balance paid over three-to-five years. Often the remaining payment was tied to performance and client retention, which shifted more of the risk to the seller.
The partners in this specific wealth management firm have become frustrated because seller expectations for price and terms have pushed many deals out of their own risk tolerance. The partners have been reluctant to take on debt to fund transactions, and they have an aversion to private equity because they do not want a passive shareholder in their company.
As they reviewed their strategy, they developed several key threshold questions for evaluating an acquisition target:
• What is the average age of the advisory firm’s clients? • What is the firm’s rate of de-accumulation? • Which staff (including the firm leaders) are likely to remain once the deal is done? • Which clients are at risk in the transition? • What has been the rate of organic growth over the past five years and what drives this? • What is our required rate of return for this investment?
This firm’s diligent analysis spawned an awakening. They decided that building rather than buying would make more sense.
They discovered that solo practitioners tend to use a multiple of revenue as their valuation metric, primarily because they cannot demonstrate free cash flow or EBITA after paying fair compensation to the lead advisor. Being savvy investors, the partners in this wealth management firm recognized that when nothing is left over after covering all expenses including compensation, it is impossible to amortize the purchase price out of current earnings.
They also saw that many solo practitioners use a revenue multiple of 2.3x, a mysterious formula that has become common in the advisory world. Assume that the practice generates $500,000 of annual revenue. At this multiple, the practice would be valued at $1,150,000. All of that would go into the pocket of the seller. The buyers would still need to spend time and money on integration, branding, staff retention, people development and a disciplined client service experience. Fees generated from the book of clients acquired would help fund the purchase price, but the ROI would be meager because of the associated costs and the demographics of the client base.
Build Rather Than Buy?
By focusing on achieving critical mass in each of their existing locations through recruitment and development, the wealth management firm realized it would have more control over the process and every dollar spent would be an investment in their own firm rather than a payout to someone who was not likely to stay with the enterprise for many years.
To build rather than buy also requires an investment, of course. This is especially true in firms that do not have a framework for organic growth.
In weighing your options, first consider what type of firm you want to be and define your optimal client. This helps to inform the future staffing model, the client experience, the technical expertise required and the development program.
Second, decide how to become an employer of choice. Most new hires will not remain fulfilled in an office managed by a solo practitioner who has no experience or desire to train them. Successful firms assign accountability for managing and developing employees, and structure compensation to promote a more team-based approach to business. The CFP Board Center for Financial Planning has developed a guide, Financial Planning Career Paths:
Building More Sustainable and Successful Businesses, for creating this type of structure.
Because our example firm has multiple locations, they must think in terms of office-by-office growth rather than attempting to develop each location simultaneously and straining limited resources. They also need to build a structure and a culture that truly leverages organic growth. It is a shift in focus. In an acquisition, buyers consider issues like synergy, cost savings, alignment of interests and other factors. In an organic growth strategy, however, the owners start with a clean slate and build a business based on their own vision rather than attempting to cobble together the conflicting interests of multiple entrepreneurs.
Regardless of the decision to buy or to build, growth is daunting. Purchasing a firm may seem more expedient, but the costs in time and money are significant and the practice and cultural conflicts are real. It takes a bit longer to create a firm organically; it requires patience and a well-thought-out structure and management strategy.
If you are a reasonably-sized firm attempting to grow, you already have processes for hiring, rewarding and developing people. You have processes for attracting new clients and providing advice. You have standards of care and quality, which you can leverage. While it is not an entirely new recipe, the components must be scaled up in order to grow at a rate faster than the average firm.
Neither approach is mutually exclusive. Decide what type of business you are trying to create and where you want to be located. Then figure out what will produce the most appropriate ROI for the risk.
Mark Tibergien is CEO of BNY Mellon’s Pershing Advisor Solutions. Tibergien is also the author most recently of “The Enduring Advisory Firm,” written with Kim Dellarocca of BNY Mellon and published by Wiley. He can be reached at firstname.lastname@example.org.